Gordon Growth Model (GGM)
- The GGM is a variation on the standard DDM that allows the analyst to assume that dividends will grow in perpetuity at a constant rate.
V0 = Div1 /(rce - gdiv)
Div1 = D0 * (1 + gdiv) = future period dividend payment
rce = by now you should know this!
In an exam problem CFA might make you derive the required return on common equity via CAPM.
gdiv = growth rate of the dividend
Note that in order for GGM to "work", the required return on common equity must be greater than the expected growth rate of the dividend.
GGM can also be used to value preferred stocks, whose dividend payments are fixed.
Preferred Stock V0 = Pref Div /r preferred stock
GGM can be appropriate when:
The analyst is looking at broad equity indexes.
The analyst is valuing steadily growing companies that pay dividends.
GGM has drawbacks of:
Being incredibly sensitive to small changes in the model inputs.
An inability to value companies that do not pay dividends.
An inability to value companies whose growth is not stable.
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- Equity Analysis Part 2 - Introduction
- Porter’s Five Competitive Forces
- Industry Analysis
- Supply and Demand Analysis
- Financial Projections in Emerging Markets
- Cost of Capital in Emerging Markets
- Cash Flows: Dividends vs. Free Cash Flows vs. Residual Income
- Dividend Discount Model (DDM)
- Gordon Growth Model (GGM)
- Present Value of Growth Opportunities (PVGO)
- GGM, Leading P/E Ratio, and Trailing P/E Ratio
- Multi-Stage Dividend Discount Models
- H-Model for Valuing Growth
- Sustainable Growth Rate